Regulatory change

Governments are responsible for regulating certain industries such as banking, insurance and telecommunications.

Governments sometimes change the legislation that will make it easier or more difficult for a particular sector to perform well.

For example, banks in most countries are required to hold a minimum amount of customer deposits in cash reserves.

Increasing this reserve requirement can mean a bank has less money to lend out to businesses.

Being able to lend less means that a bank earns less interest. This can therefore have a negative impact on bank share prices.

Because of the interconnectedness of the economy, changes to the rules governing one sector can also impact on the health of companies in another sector, and their share prices.

Raising banks' reserve requirements for example has an impact on individual companies, which often rely on bank finance to fund their own growth. Reducing companies' ability to borrow from banks can therefore pull down their share price as well.

However, the opposite can be true. If a government lowers the reserve requirement, then this can have a positive effect on the share price of banks and companies that are exposed to borrowing costs.

It is prudent, therefore, to keep and eye on legislation that could affect the share price of the companies that you consider.

Legislation to increase banks' reserve requirements can hurt banks' share prices because they are able to lend less and earn less interest. It can also hurt corporate share prices as companies are able to borrow less to fund their operations.

Taxation

Every company is subject to various forms of taxation, either directly or indirectly, and changes in taxation will affect their performance and share price.

A change to the corporate tax a company must pay is probably the most obvious to look out for as this will directly impact how much profit it makes.

An increase in corporate tax can even force a company to relocate in order to find a more favourable tax regime in which to operate.

Taxes on specific goods or resources can also impact on the profitability – and therefore share price – of related industries.

For example, if the government raises fuel tax, companies like airlines or couriers that use a lot of fuel can see their profit margin eroded.

These companies may then choose to pass on their higher fuel costs as higher prices for customers. This could hit demand for their products or services, and therefore reduce their revenue.

Therefore, when you are looking at a company and considering whether to buy or sell its shares, you should be aware of not only any specific tax changes that may affect its profitability, but also any tax changes on the resources that the company uses.

Raising tax on goods that companies need to buy a lot of can hurt their share price because higher costs can mean lower profits. If companies pass those higher costs onto consumers in the form of higher prices it can also reduce their revenue.

Monetary policy

Monetary policy refers to the control of money supply in the economy and governments use it to either stimulate or cool an economy that they think is growing too slowly or is suffering from high inflation.

One way of stimulating an economy is for the central bank to lower interest rates. This reduces businesses' and consumers' borrowing costs, which frees up cash for spending and investment.

Lower interest rates will therefore tend to boost share prices as a company has lower costs and can invest more in its future growth while consumers have more money to spend on its goods or services.

In contrast, raising interest rates tends to increase a company's costs at the very time that consumers have less money to spend on its goods and services. Raising interest rates can therefore push down corporate share prices.

Governments can also buy government bonds to flood the economy with money. This is also referred to as printing money.

Quantitative easing is slightly different to this and involves the government buying financial assets from commercial banks and other institutions to inject money into the economy.

Increasing the money supply tends to lift consumer spending, so can have a particularly positive effect on the share prices of companies in the retail sector, for instance, which tend to see their revenue rise at these times.

Lower interest rates can boost share prices as companies' borrowing costs fall and they are able to invest more in their future growth. Consumers' borrowing costs also fall, giving them more money to spend on companies' goods or services.

Fiscal policy

Fiscal policy is where the government undertakes spending programmes to stimulate the economy, for example through big infrastructure projects.

Different sectors will feel the benefit depending on where government spending is focused.

If a government invests more in areas such as affordable housing, for example, the share price of construction companies can be the first to benefit as they win new business building homes and roads.

You should therefore consider how any government announcements of increasing or decreasing spending could affect the profitability of the company you watching.

Government spending programmes can boost companies' share prices by creating more demand for their goods or services. Investing in affordable housing for example can lift construction companies' share prices.

Summary

In this lesson you have learned that …

… a country's government shapes the business environment in which companies operate, so its policies – changes to regulations, taxes or interest rates – have a huge impact on individual companies' performance and share price.

… governments are responsible for regulating certain industries and will sometimes change legislation making it easier or harder for a particular sector to perform well.

… every company is subject to various forms of taxation and changes here will affect its performance and share price.

… lowering interest rates is one way the government has of stimulating the economy – it tends to boost share prices as companies have lower borrowing costs and can invest more in their future growth while consumers have more money to spend on goods and services.

… raising interest rates tends to increase a company's costs at the very time that consumers have less money to spend on its goods and services – this can therefore push down share prices.

… buying government bonds or quantitative easing are other ways the government can inject money into the economy – this tends to be good for banking and retailer shares.

… government spending programmes can boost companies' share prices by creating more demand for their goods and services.

Markets.com

Minimum Deposit

$100

Average Spread

2,2 pips

Regulation

CySEC, FSB

Founded

2010

Why

Get 12-month Premium Membership for free. Deposit and send us an email to premium@tradimo.com to claim your free Premium Membership.

Risk warning: Trading in financial instruments carries a high level of risk to your capital with the possibility of losing more than your initial investment. Trading in financial instruments may not be suitable for all investors, and is only intended for people over 18. Please ensure that you are fully aware of the risks involved and, if necessary, seek independent financial advice. The educational content on Tradimo is presented for educational purposes only and does not constitute financial advice.